221. The history of the Commission's interest in
harmonisation of corporate tax goes back to the report in 1962
of the Sagré Committee[140],
which laid down three requirements for fiscal neutrality so that
corporate taxation would not distort the market: the tax system
should not influence the choice of the location of investment;
it should not influence the choice of whether the investment is
made directly or intermediated; and it should not provide an incentive
for favouring one type of investment or one method of financing
investment over another. Malcolm Gammie pointed out that the Commission
had not built on this report by making concrete proposals (p 139),
and Michael Devereux agreed that "it is difficult to discern
any particular movement over the last 30 or 40 years" (Q
379).

222. We have already noted[141]
that there is no explicit legal basis for advancing Community
measures on direct taxation, and no Treaty requirement that corporate
or other direct taxes should be harmonised. As Peter Wilmott said:
"All there is is a requirement to harmonise indirect taxes
to the extent necessary to establish adequate functioning
of the common market or now the internal market. There was no
direct reference to direct taxation". He added that by the
1960s "people were coming to see that you could not make
an artificial distinction between indirect taxes and other
forms of taxes on income, whether personal or corporate [that
is, direct taxes]" (Q 391). But he thought that the lack
of an explicit legal base might explain why the EU did not have
a tax "policy", when it was "riddled with policies
of one kind or another - agriculture, transport, trade, whatever"
(Q 384). Our witnesses explained that devising a satisfactory
system of corporate taxation presents technical as well as political
problems. As market integration increases, it is increasingly
difficult to say in which tax jurisdiction a company actually
earns its profits, a problem faced by national tax authorities,
which thus often have to make arbitrary decisions, and recognised
by the OECD (Q 274). Michael Devereux suggested that although
one can devise rules for attributing profit between tax jurisdictions
"in economic terms [it] is almost a meaningless concept"
(Q 382)[142].

223. The most recent attempt to come to grips with
the issue of corporate tax harmonisation was the 1992 Ruding Committee
report[143],
which assessed the severity in existing cross-country distortions
arising from separate corporate tax regimes, and the scope for
limited measures to improve matters. On the basis of a business
survey and other evidence, it concluded that corporate tax differences
were an important factor in business location decisions, but were
even more significant in the financial activities of a company.
Its major recommendations to resolve the problems included measures
to harmonise the corporate tax base (including historic cost depreciation
allowances, and a uniform tax treatment of intangibles such as
"goodwill"); a minimum tax rate of 30 per cent; and
anti-discrimination proposals, including the abolition of withholding
taxes on dividends, interest and royalties, and improved procedures
for dealing with transfer pricing disputes. These ideas have not
been taken up, and there has been no Commission initiative to
provide, or even move significantly towards, a comprehensive solution.

224. The Government considers that it is "highly
likely" that the relatively low level of corporate tax in
the United Kingdom has influenced the location of industry, although
the formal evidence is unclear (Q 142). It is generally agreed
that corporate tax has an influence on the location decisions
of companies, particularly for more mobile industries; in principle,
it would be expected that these decisions would reflect the effective[144]
rather than the nominal rate of tax. But of course, as Judith
Mayhew (for the Corporation of London) said, "there are other
issues people look at: such as the flexibility of the labour market;
the availability of highly skilled workers; the infrastructure
available; transport; education; telecommunications; the
IT infrastructure; the right types of buildings; and international
access" (Q 109). State aids or other incentive measures will
also influence decisions.

225. Malcolm Gammie summarised the dilemma as follows:

"It may be plain to see the good sense
in harmonising corporate profit taxes within a single market.
It is unsurprising, however, that it is proving so intractable
a task within Europe when corporate taxation has no clear theoretical
basis, no agreed form and an uncertain jurisdictional basis -
both in terms of the basis for claiming tax and the amount of
the claim. And there is no legal framework within which to attempt
to resolve any of those issues" (p 141).

226. We considered whether the lack of a harmonised
or co-ordinated framework for corporate taxation actually mattered.
UNICE[145]
supports the argument that the current diversity of tax systems
is an obstacle to cross-border integration. Malcolm Gammie listed
a number of problems arising from the current diversity of systems[146],
not least the sheer cost of complying with fifteen different tax
régimes. He concluded that without co-ordination at Community
level companies faced significant compliance and administration
burdens, with a risk of double taxation "because countries
will try and allocate too much profit to their particular jurisdiction"
(Q 389).

227. There are various views on what the solution
might be. Malcolm Gammie floats the idea (p 142) of what
he calls "home State taxation", where companies would
compute and pay tax solely by the rules of their "home State",
and the revenue would be divided according to where the company
conducted its operations and activities within Europe. The CBI
did not favour a universal integrated system, but with the aim
of "enabling companies to do business as if they genuinely
operate in a single European market" (Q 316) they were interested
in the idea of an optional single European corporation tax, whereby
companies with interests in several Member States could choose
to be taxed on a single consolidated result. They accepted that
there would then be a need for a single body (which they assumed
would be the Commission) to administer the régime (Q 317);
and they recognised the need for careful transitional arrangements
"to ensure that there was a satisfactory toll-free transition
from the current system to the optional European system"
(Q 318). They did not believe that the existence of a parallel
optional régime would inhibit Member States from setting
their own corporation tax régime: "nor should it"
(Q 328)[147].
There is however an issue of how the proceeds of such a tax might
be allocated. Barclays Bank shrugged this off, referring to "one
EU cake of profit that is returned once and divided up between
the Member States on whatever appears to be a sensible basis"
(Q 22). There is a danger that the information which might be
needed to construct "a sensible basis" could be just
as complex to prepare as tax returns are now, so Malcolm Gammie
thought that there might be moves towards the sort of allocation
by formula which operates as between states in the USA (Q 389).

228. There are some recent signs of movement in this
area. The Paymaster General told us that the Commission had been
asked to bring forward a mandate for a study on corporate taxation,
and that the Government had "insisted that the Commission
should also be required under the mandate to consider the beneficial
impact of tax competition on the competitiveness of European business
and employment in Europe". She promised that Parliament would
be notified when the mandate was agreed (Q 421). Meanwhile, the
Government's view was clear:

"We actively argue against harmonisation
of corporate tax rates. We do not believe that is the way forward.
We want a competitive United Kingdom and European economy facing
outwards into the global market and engaging in it. Questions
about harmonisation of tax rates or bases are not helpful in those
objectives" (Q 447).

The views of other Member States vary. We were told
that "Germany probably could not agree on the harmonisation
of the normal corporate income tax rates"(Q 200).
France does not wish "to harmonise corporate tax in the same
way as we tried to do it for VAT" (Q 244). The Luxembourg
Minister of Justice and the Budget, on the other hand, "would
like to see a Directive on corporate taxation being adopted in
parallel with a Directive on savings"[148].

229. We asked some of our witnesses to predict what
might happen in this field. Malcolm Gammie believed that if corporate
taxation was to be maintained at all rather than just withering
because of the process of competition between Member States[149],
Community measures of some sort would eventually be necessary.
"The practicalities of running a [different] system in different
Member States will reach a point where governments are persuaded
that actually it is better to agree on a set of measures than
to allow matters just to continue to develop through market pressure".
The real question was whether the Community would wait until it
was driven to action, or devise a policy in advance (QQ 404-405).
"If you asked companies what they would like", he said,
"they would prefer to have a coherent proposal that resolves
all these issues rather than having to do it by an incremental
process over many years" (Q 390). Peter Wilmott agreed that
the initiative for change was more likely to come from business
than from governments: "The more [companies] see that they
are at the mercy of forces which they cannot understand or master,
which may be either market forces literally in the sense of competition
between tax jurisdictions or court cases at the national or European
level that may or may not produce rational answers to the questions
which were put to them, the more they feel that is unacceptable
and the more likely they are" to ask the Commission to produce
a proposal (Q 405).

232. We discussed above[150]
the minor proposals which the Commission has made for amendments
to the current system of VAT. But the Commission has also published
a Communication[151]
which, although it makes no legislative proposals, floats ideas
for fundamental changes to the VAT régime.

233. The current system of VAT is destination-based.
For goods which are to be exported, no tax is paid in the Member
State of origin, but VAT is imposed in the importing country.
Tax can therefore be fraudulently evaded by diverting goods which
have been zero-rated for export back into the domestic shadow
economy. The abolition in 1993 of frontier formalities for goods
traded across internal EC borders, as part of the completion of
the Single Market, was bound to increase the scope for such fraud.
The Commission therefore made proposals in 1987[152]
which would have ended zero-rating on exports within the EC, introducing
instead a VAT system which would have taxed goods and services
in the same way whether they were destined for consumption domestically
or in another Member State. Thus sales to other Member States
would have become subject in the exporting Member State to VAT,
credit for which would have been given by the authorities in the
importing Member State. The Commission refers to this as the "origin-based
system".

234. In the event, these proposals were not agreed;
instead the zero-rating arrangements were retained, with some
modifications. However, the danger of increased fraud as a result
of the abolition of checks at borders was recognised. This system
was therefore explicitly designated the "transitional
régime", and a commitment was added to the Sixth
VAT Directive that it should be replaced by a "definitive
régime" which would be based on taxation in the
country of origin. The Commission was supposed to submit proposals
for such a system by the end of 1994, and it was generally expected
that they would be based on the same principles as the Commission's
former (1987) proposals.

235. Before any specific new proposals had come forward,
however, the October 1994 ECOFIN Council laid down the ambitious
criteria which any new régime would have to satisfy. It
would have to be demonstrably better than the present system,
and in particular to represent a fundamental simplification of
the system with no distortion of competition; reduce burdens on
businesses and administrations; ensure that the right revenue
reached the right Exchequer at the right time; and create no increased
opportunity for fraud. The UK Government had its own fifth condition,
the ability to maintain those zero rates in force at the time
the definitive system was adopted.

236. The Commission did not consider that a system
based on the 1987 proposals could meet these objectives. It therefore
produced in July 1996 a Communication on A work programme for
progression to a new common system of VAT for the Single Market[153],
exploring ideas for a definitive régime. Commissioner Monti
left us in no doubt of the Commission's ambitions when he said
that the proposal was "designed both to modernise and simplify
the existing VAT system and in due course to transform it into
a real common system with a single place of taxation[154]
for a company in its country of origin" (Q 229). The essential
characteristic of the new régime would be that each business
in the EU would have a single place of registration, taxation
and deduction of input tax. This would mean the elimination of
any distinction between domestic and cross-border transactions
within the Community: all the Community-wide business of a firm
would be taxed on the basis of the legislation of the country
in which the firm was registered. There would be a new mechanism
for redistributing VAT revenues, on the basis of statistical data
on consumption rather than declarations by businesses. Commissioner
Monti pointed out that unless some system of this kind was introduced,
as it had been successfully in Canada, there would have to be
a complex clearing system which would negate the potential benefit
to business of having to complete only one set of returns (Q 236).

237. HM Customs and Excise considered that the advantages
of the single place of taxation might be over-rated, as far as
small businesses were concerned. They told us that of some 1.6-1.7
million businesses registered for VAT in the United Kingdom, only
some 70,000-80,000 were involved in importing or exporting (Q
362). And even if a United Kingdom firm was engaged in cross-border
trading, it would under the present system have to register and
account for VAT in another Member State only if it was selling
goods direct to individuals in that country by mail order or from
a shop, not if it was simply exporting goods. For services, the
normal place of supply is where the supplier is established[155],
so cross-border provision should not create VAT complications.
And even where there might be liability for VAT in another Member
State, only firms exceeding the turnover threshold would have
to register. It follows that it is only larger businesses with
multinational operations which are likely at present to be required
to register in more than one Member State, and which would therefore
benefit from a new system. Smaller United Kingdom businesses might
actually suffer if the paperwork became more complex (QQ 352-353).

238. HM Customs and Excise do not deny the danger
of fraud arising from the zero-rating of exports. But Martin Brown
suggested that changing to the origin system would simply change
the nature of the fraud, with importers claiming VAT refunds when
no goods had changed hands (Q 358). Under either system, evasion
could only be overcome through mutual assistance, using spot audits
checked with other Member States through the VAT Information Exchange
System (Q 359). The risk of fraud would not be removed by the
single place of taxation system; it would now no longer relate
specifically to export transactions, but would be liable to arise
for any trades between companies registered for VAT in different
Member States. Moreover, HM Customs and Excise had doubts about
whether the proposed system of revenue allocation could work,
given the difference in Member States' statistical systems and
tax collection systems (Q 353).

239. We considered whether a common VAT system
would necessarily imply common rates of VAT. The Commission
Communication says that the new system would require the Member
States "to embark on a legislative harmonisation process
which is more extensive than has ever before been contemplated
in the field of indirect taxation in order to restore the
economic efficiency of VAT as a system of taxation"[156].
It claims that "the introduction of a single [standard] rate
would provide a perfect solution avoiding any tax-related distortion
of competition and, above all, ensuring that the tax is applied
simply and uniformly throughout the Union[157]
- nevertheless, an approximation within a band could prove sufficient.
The decision setting the rate should be a political one and should
take account of the general need for sufficient revenue, the need
to share the burden among the main types of statutory contributions
and charges (direct taxation, indirect taxation, social contributions)
and the thrust of medium-term tax policy". Harmonisation
of the number and scope of reduced rates "is necessary from
a purely technical standpoint The Commission remains convinced
that only a small number of rates is compatible with the objective
of simplifying the tax"[158].
And exemptions and other derogations should be limited in order
to ensure as wide a base as possible for the tax.

240. In his evidence to us, Commissioner Monti was
clear that, with a single place of taxation, "a higher degree
of convergence of rates" would be needed (Q 235), but he
did not specify whether he thought that rates or bases would have
to be identical. HM Customs and Excise explained (Q 349) that,
under the present arrangements, Member States could opt for two
reduced rates[159],
but in addition they were allowed to continue to use lower (or
zero) rates that were in operation before the Directive came into
force. It was under these provisions that the United Kingdom continued
to zero-rate goods like public transport, young children's clothing,
food, books and newspapers. Some other Member States had a zero
rate, and some had rates between zero and 5 per cent for various
products.

241. The Irish Government takes the view that a certain
initial degree of VAT approximation was essential for the Single
Market to function; but it considers that this level was largely
achieved by 1993, and that whereas in general the present system
works well, plans for a common VAT system "would most likely
create problems". It sees strong barriers to political agreement
on a new system (p 176). The Chairman of the CBI Tax Committee
believes that "a single [VAT] taxation base for ease of registration
and compliance requirements is the sort of thing that the Single
Market should facilitate", though "that does not necessarily
mean that the whole European system must be totally harmonised
and made more rigid" (Q 326). But he recognised that with
a single place of taxation there would have to be "a reasonable
approximation of rules", and measures to stop firms from
exploiting differences in rates (Q 330).

242. Sectors with special interests have drawn our
attention to their concerns. The Food and Drink Federation claims
that abandoning the zero rate of VAT on basic foodstuffs "would
threaten United Kingdom economic stability by adding to inflation,
would hit poorer households particularly hard, [and] would
cause considerable damage to the industry's competitiveness";
it considers that "it is quite possible to simplify the VAT
system without threatening the zero rate" (pp 173-174). The
Newspaper Society asks us to "recommend the avoidance of
the harmful consequences of harmonisation, through preservation
of the zero rate on the printed word", arguing that such
matters should remain the prerogative of Member States (pp 179-180).
The House Builders Federation tells us that: "Across Europe
the industry believes that VAT harmonisation on housing would
damage employment in construction and reduce access to housing"[160].

243. Asked whether he thought further harmonisation
of VAT was essential for the success of the Single Market, Martin
Brown of HM Customs and Excise replied: "We have got a Single
Market that works at the moment". The big step forward had
been getting rid of frontier documentation in 1993: even the Commission
accepted that the transitional system "has, on the whole,
functioned satisfactorily". Further minor adjustments would
be needed to deal with inconsistencies, "but not harmonisation
of rates, not harmonisation of coverage according to the grand
vision of the Commission's Communication" (Q 354).